Park Hotels & Resorts Stock: Asymmetrical Returns In The Cards (NYSE:PK) (2024)

This article explores real estate investment trusts (REITs), with particular emphasis on Park Hotels & Resorts Inc. (NYSE:PK), an asset that has surged by more than 25% since we last covered it in October.

Our basis for assigning a buy rating in October was Park Hotels & Resorts' operational prowess and PK REIT's valuation. However, various events have occurred since our latest coverage, prompting us to revisit Park Hotels & Resorts' prospects.

Herewith are our latest findings.

Fundamental Analysis

Portfolio

Contextualizing

Let's reaffirm a few of PK REIT's key data points before moving into a more comprehensive analysis.

As displayed in the diagram below, Park Hotels & Resorts derives approximately 63% of its revenue from room bookings. Furthermore, the REIT generates secondary revenue from ancillary hotel services and food and beverage. Additionally, PK REIT generates "other income" from lease income and resort fees.

The abovementioned data coalesced to deliver $639 million in first-quarter revenue and 52 cents per share in funds from operations. Although a cyclical fund, Park Hotels & Resorts has secular exposure deriving from high-growth markets such as Hawaii. Moreover, PK REIT has solid diversification benefits, as its 26,000 rooms and layered revenue streams reduce concentration risk.

Let's discuss Park Hotels & Resorts' latest portfolio performance to determine what this hospitality REIT has in store.

An Active Look At Key Metrics

Park Hotels and Resorts' latest financial statements convey numerous talking points. The following diagram illustrates a time series thereof; a discussion follows.

Firstly, as shown above, Park Hotels & Resorts' first-quarter occupancy increased by 350 basis points to 70.9%, which we believe is a splendid number, given that U.S. hotel occupancy settled at 63.8% in 2023.

Although Park Hotels & Resorts' rising occupancy derived from various sources, its resort business played a pivotal role. In fact, we think its resort business will do particularly well during the northern summer due to the holiday season. Additionally, airport offerings could fold into the summer season benefits due to transient stayovers during transit to holiday destinations.

The following diagram illustrates much of what I mentioned before. However, it adds Park Hotels & Resorts' illustrious revenue per available room growth in recent years. Moreover, take notice of the REIT's hotel EBITDA expansion, which we find impressive, given that broad-based inflation has tabled input cost issues to most businesses.

Despite the positives mentioned, keep in mind that, unlike traditional REITs, hospitality REITs rely on short-term bookings instead of long-term leases. As such, seasonal and cyclical growth mustn't be confused with long-term growth.

I conclude this section by embedding a chart that shows Park Hotels & Resorts' regional data. We think it illustrates low concentration risk. However, the abovementioned seasonality and cyclical growth factors mustn't be neglected.

An Asset-Specific Discussion

Below is a collage of Park Hotels & Resorts; a discussion of recent developments follows.

Capital expenditure intensity is an issue with resorts, as upkeep is arduous. Although expenses can be depreciated on a pre-tax basis, they tie up capital that could've been invested in external growth. Nevertheless, upkeep and expansion occasionally scale revenue.

Park Hotels & Resorts has numerous short-term capital commitments pertaining to expansions and renovations.

We see immense potential in the Hilton Hawaiian Village Waikiki Beach Resort development. The Hawaiian Resort market is anticipated to grow by 5% until 2033, and PK REIT derives approximately 35% of its revenue from the region.

PK REIT's notable market participation, paired with a high-productivity business model, can lead to lower cyclicality and pricing dominance within the regional hospitality market. Furthermore, Park Hotels & Resorts has a promising development pipeline of $1.5 billion with a horizon until 2037.

The REIT claims it will yield a return on investment between 15% to 25% on its pipeline. Although one must be careful to believe long-term internal forecasts, the forecast makes fundamental sense as the average U.S. hotel annualized ROI is between 10% and 14% (in 2023). With all economic factors constant, PK REIT's investment pipeline will probably yield at least 100 basis points higher, given its robust market positioning and credibility with creditors (allowing for a lower cost of debt). Moreover, PK REIT has a comprehensive cash & equivalents base of $378 million, providing a current ratio of 1.3x, which we deem solid, as REITs usually have easy access to external capital.

Asset-Liability Relationship

A REIT's performance is often only as good as its asset-liability interrelationship.

PK REIT has $3.5 billion in net debt with a Net Debt/EBITDA Ratio of 5.2x, which we think is high, given that it is above the generally accepted threshold of 3x. Additionally, PK REIT operates in a cyclical industry, meaning high leverage presents risks. However, despite being highly leveraged, 95% of the REIT's debt is fixed, lowering its liability-level volatility. Moreover, we think its 5.24% weighted average cost of debt is low as PK REIT has a hotel EBITDA margin of 27.3%.

The diagram above includes most of the information presented in the following diagram. Nevertheless, I thought it would be more convenient to observe the maturity structure in histogram format.

Notice how PK REIT has a large chunk of its mortgage debt maturing in 2026. This is a critical observation as it will likely refinance at that stage, which presents risks due to the resilient mortgage and interest rates embedded in today's bond market. However, having said that, we believe PK REIT's funding cost risks remain minimal due to its robust EBITDA margin.

Valuation

PK REIT's guidance projects that its funds from operations (FFO) will settle between $2.07 and $2.27 by the end of its 2024 fiscal year, which isn't far from Seeking Alpha's midpoint guidance of $2.19.

If Seeking Alpha's guidance is used, the REIT has a forward price-to-FFO ratio of 6.81x, which is below the sector median of 14.80x, suggesting PK REIT is relatively undervalued. Sure, the multiple must be considered; however, we think the REIT's forward price-to-FFO provides a good outline.

Furthermore, a technical vantage point of PK REIT signals pessimism. For example, PK REIT is trading below its 10-, 50-, 100, and 200-day moving averages, communicating a downward trend in its market price. Moreover, PK REIT has a Put/Call Ratio of 1.44x, reflecting negativity from options traders.

Despite the negativity mentioned above, both metrics are often considered countercyclical. As such, a "buy the dip" opportunity may be in the cards.

Dividends

A glance at PK REIT's dividend profile suggests it is a good investment for those seeking income. For example, it has a 5-year average yield on cost of 5.39%, which is higher than the sector median. Moreover, it has a forward dividend yield of 6.7%, which is higher than the 4.59% trailing yield experienced by the average U.S. equity REIT in 2023.

Despite PK REIT's dividend being lucrative at face value, we reiterate the fact that it operates in a cyclical industry and probably won't provide "throughout-the-cycle" returns.

Risks To The Analysis

The primary risk to this analysis is that it ignores prominent macroeconomic variables. For example, factors such as flimsy U.S. consumer sentiment, stagflation, and rising unemployment rates could dent the hospitality industry and PK REIT in particular. We are especially concerned by stagflation as this short-term occupancy REIT needs to adjust its prices relative to inflation, meaning we could observe flat NOI in the coming quarters.

Furthermore, we are concerned by PK REIT's risk-return characteristics. For instance, PK REIT has a negative Sharpe Ratio, suggesting its volatility-adjusted returns are poorly aligned. Moreover, it has a much lower Sharpe Ratio than the SPY ETF (SPY), conveying that it might onboard inefficiencies to traditional portfolios.

Final Word

Upon assessing PK REIT, we discovered numerous distinctive advantages, such as growing revenue per available room. Moreover, the REIT's lodging business could benefit from a seasonal uptick during the summer holidays.

Further, we like PK REIT's capital structure, especially if compared to its asset-level returns and investment pipeline. In fact, we believe these factors play an important role in its impressive relative valuation.

Although PK REIT faces risks such as technical pricing pressure and macroeconomic uncertainty, we think the positives outweigh the negatives. Thus, we maintain our Buy rating.

Consensus: Buy/Market Outperform

Pearl Gray Equity and Research